What Affects Small Business Growth? Part IV: Capital

Having already discussed how founder experience, background and aspirations affects business growth, I’d like to talk about capital.  This is the eight hundred pound gorilla in the small business world – whether you internally generate financial capital or raise it externally, you can’t grow without it.   Financial capital offers you, the business owner, the ability to implement growth strategies, hire talented employees, develop better products and explore new markets.  

While numerous studies have documented that financial capital does indeed affect revenue and employment growth, the most interesting demonstration of the role of financial capital comes from studies that show what happens when you don’t have capital.  Researchers Fairlie and Robb, through two large sample studies using data from the Census Bureau, the first comparing black business owners to white business owners and the second comparing women owners to male owners, show the extent to which lack of access to capital can influence the growth and survival of companies.   They found that the disparity in access to capital explained 23.6 percent of the difference in sales between black and white firms, 36.9 percent of the difference in number of employees, and 43.2 percent of the difference in rate of closures.   For differences between women and male owners, difference in access to financial capital was responsible for 15 percent of the difference in sales, 32 percent of the differences in number of employees, and 44.7 percent of the difference in rate of closures.

Financial capital, though, isn’t the only important form of capital.  Of course, there is “human capital” – the experiences, skills and personality traits you bring to the table as I discussed in earlier posts, but increasingly human and financial capital cannot explain in entirety why some companies grow and others don’t.  The final form of capital is social – the resources mobilized through your social networks.  Because this form of capital is less visible and less tangible than the other two forms of capital, this is what is often at work when business owners talk about the “luck” component of success (there is no such thing as luck!).

There are a myriad studies that show how social capital affects people and businesses.  Here are a few that pertain specifically to small businesses and their growth.

In a now-classic in-depth study of apparel firms, researcher Uzzi showed that strong ties to business groups – or informal groups of independent businesses linked through friendship, family or shared equity ties – had greater chances of survival and attributed this to trust between the parties that lead to the sharing of resources and joint problem-solving.  In a study of 973 businesses that participated in the hospital software systems industry over 30 years, researchers Singh and Mitchell showed that the chance of a business dying increased when its strategic partner stopped operations or created a linkage with a different firm.  

Social capital can be a little more complex than just having a lot of relationships.  Researcher Stuart showed that not all relationships have equal effect on growth.  Through a study of 150 semiconductor firms, he showed that firms that have alliances with bigger partners (in terms of revenue) enjoyed growth than firms that had alliances with smaller partners.  He explained that this is because of the reputational advantages of being associated with a large, well endowed firm in addition to the greater access granted through these bigger partners to customers and distribution channels.

The relationships that a firm maintains matter, but so do the relationships of the contacts themselves.  Maintaining a network in which contacts are not connected to each other can be more beneficial because they can provide information and resources that are unique and non-redundant to what other contacts in the network can provide.  My own study of 256 Silicon Valley entrepreneurs showed that the less connected the entrepreneurs’ contacts are to each other, the greater the amount of financial capital entrepreneurs were able to receive.  Greater financial capital, as shown in the previous section, is associated with greater growth.   

Finally, the attention received by business incubators and industry clusters for their positive impact on business and economic growth highlight what is essentially the positive impact of networks across organizations.  Incubators are an option for businesses that want to reduce costs by sharing equipment and support staff and to receive onsite counseling and consultations.  Beyond these benefits, incubators facilitate peer-to-peer mentoring and the leveraging of each others’ networks.  Furthermore, belonging to an incubator can increase the legitimacy of start-ups, increasing the likelihood that suppliers and clients will want to work with them.   Likewise, industry clusters, or “geographic concentrations of interconnected companies, specialized suppliers, service providers, firms in related industries, and associated institutions” according to researcher Porter, offer considerable cost savings to members of the cluster thanks to greater access to specialized input suppliers and business services, a larger pool of specialized workers, and greater likelihood of attaining public infrastructure that is oriented towards that particular industry.  

-Mina

Coming up next:  Management team and business growth

Sources:

Fairlie, R. W. and A. M. Robb (2007). "Why are Black-owned businesses less successful than white-owned buinesses?  The role of families, inheritances, and business human capital." Journal of Labor Economics 25(2): 289-323.

Fairlie, R. W. and A. M. Robb (2009). "Gender Differences in Business Performance: Evidence from the Characteristics of Business Owners Survey." Small Business Economics v33(n4): 375-95.

Porter, M. (2001). Cluster of innovation:  Fregional foundations of U.S. competitiveness. Council of Competitiveness, Washington, D.C.

Stuart, T. E. (2000). "Interorganizational Alliances and the Performance of Firms: A Study of Growth and Innovation Rates in a High-Technology Industry." Strategic Management Journal 21(8): 791-811.

Uzzi, B. D. (1996). "The sources and consequences of embeddedness for the economic performance of organizations:  The network effect." American Sociological Review 61: 674-698.

Yoo, M. (2004). "Ties that unbind: Networks and performance among Silicon Valley immigrant entrepreneurs."